17 February 1999 e9902095.txt - ADJUSTED COST BASE OF NOTE

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1) Non-arm’s length transfer of CCPC shares from husband to wife pursuant to subsection 73(1) in return for a demand, secured interest-free note having a face amount equal to the FMV of the shares or alternatively, some lesser amount. What is the ACB of the note?

2) Upon the husband’s death, his shares are transferred to a spousal trust pursuant to subsection 70(6) in exchange for a demand secured interest-free note having a face amount that is less than the FMV of the shares. What is the ACB of the note?

Position:

We will not comment on the determination of an ACB of a note since it is a question of fact.

Reasons:

Whether the adjusted cost base of a note is equal to the face value of the note is a valuation issue since the value of a non-interest bearing note may be different than the value of an interest-bearing note. Accordingly, we will not comment on this matter since it is a question of fact.

XXXXXXXXXX 990209
G. Moore
February 17, 1999

Dear XXXXXXXXXX:

Re: Subsections 73(1) and 70(6) of the Income Tax Act

This is in reply to your letter of January 19, 1999, in which you asked for our comments regarding the following hypothetical situations:

Situation # 1

Mr. A owns shares of a Canadian-controlled private company having an adjusted cost base (“ACB”) of $100 and a fair market value (“FMV”) of $1,000. Mr. A transfers these shares to Mrs. A in exchange for a demand, secured interest-free note having a face amount equal to the FMV of the shares or alternately some lesser amount such as $500. You believe that subsection 73(1) of the Income Tax Act (the “Act”) will apply so that the transfer to Mrs. A will occur on a rollover basis and that the ACB of the note received by Mrs. A will equal the face value of the note ($1,000 or $500 in the above example). If the note did not have an ACB equal to its face amount, then on the eventual sale of the shares and repayment of the note, a capital gain of $900 will arise on the shares and another capital gain will arise to the extent that the ACB of the note was less than the face amount received on the repayment.

Situation # 2

Mr. A’s will provides that after his death, the above shares are transferred to a spousal trust in exchange for a demand, secured interest-free note having a face amount equal to $700. Providing the terms of paragraph 70(6)(b) of the Act apply, the shares will be transferred to the spousal trust on a rollover basis pursuant to subparagraph 70(6)(c)(ii) of the Act. The note received by the estate will have an ACB equal to its face amount. If the note does not have an ACB equal to its face amount, a gain will arise on the repayment of the note.

You have asked if we agree with your comments in these two situations.

Our Comments

The particular circumstances outlined in your letter appears to relate to a factual situation involving specific taxpayers. As explained in Information Circular 70-6R3, Advance Income Tax Rulings, it is not our practice to comment on proposed transactions involving specific taxpayers other than those in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a transaction that is already in progress, you may wish to submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments which may be of assistance to you.

Situation # 1

We have enclosed a copy of Interpretation Bulletin IT-511R, Interspousal and Certain Other Transfers and Loans of Property, which addresses the income tax consequences of property transfers and loans between spouses. Generally, the Income Tax Act (the "Act") provides that income earned and capital gains and losses realized on property transferred or loaned from an individual to the individual's spouse (and on property substituted for that property) are generally deemed to be the income, gains or losses of the individual and not of the individual's spouse. An exception to this rule occurs where fair market value consideration is paid by the spouse.

A transfer for fair market value consideration is not considered to have taken place for purposes of the Act unless a number of conditions are met. Pursuant to subsection 74.5(1), income or loss from transferred property or any taxable capital gains or allowable capital losses on the disposition of the transferred property does not attribute to the transferor in a particular year where:

(a) the sale or other transfer is made to the transferor's spouse for consideration equal to fair market value of the transferred property,

(b) the sale price or other consideration for the transfer is

(i) fully paid by the transferee in cash or kind (and not from property furnished by the transferor) or

(ii) satisfied in whole or in part by indebtedness on which interest is charged at a rate not less than the lesser of

(A) the prescribed rate and

(B) the rate that would be agreed upon between arm's length parties under similar circumstances

at the time the indebtedness is incurred, if all such interest is paid no later than 30 days after the end of each calendar year in which it becomes payable, and

(c) the transferor elects not to have the provisions of subsection 73(1) apply (i.e., any gain or loss is realized at the time of transfer).

If the interest in (b)(ii) is not paid within the described time then the indebtedness will not meet the requirements for exemption from the attribution rules under subsection 74.5(1) in the particular year or in any later year.

Ordinarily, the disposition of capital property results in a taxable capital gain, based on any appreciation in value, to be included in the transferor's income. However, subsection 73(1) of the Act provides an exception to this rule for an inter-vivos transfer of property to a spouse. Subsection 73(1) provides that where an individual transfers capital property to his or her spouse and both are resident in Canada at the time of the transfer, the particular property transferred shall be deemed to have been disposed of for proceeds equal to the adjusted cost base of the property immediately before the transfer and to have been acquired by the individual's spouse for an amount equal to those proceeds. Any taxable capital gain or allowable capital loss from the subsequent disposition of the property by the spouse is attributed to the taxpayer by virtue of subsection 74.2(1) of the Act. The transferor may elect in his or her tax return for the year of the transfer to not have the provisions of subsection 73(1) apply. If the election is made, paragraph 74.5(1)(c) of the Act provides that the gain or loss from a disposition of the property by the spouse will not be attributed to the transferor in any year in which the spouse subsequently disposes of the property.

If the transferor does not elect out of the provisions of subsection 73(1) of the Act, he or she is not required to report any capital gains resulting from the sale of the property to their spouse. However, any dividends or other income earned by the property after the sale to the spouse, will be deemed the transferor's income and any capital gains or losses realized on the subsequent disposition of the property will be deemed the transferor's capital gains or losses.

In Situation # 1, assuming that the requirements of subsection 73(1) are met, and that Mr. A and Mrs. A do not elect to not have subsection 73(1) apply, the CCPC shares that are transferred to the taxpayer’s spouse would be deemed to be disposed of at the time of the transfer by Mr. A for proceeds equal to the adjusted cost base of the shares to Mr. A immediately before the transfer. Mrs. A would be deemed to have acquired the shares at that time for an amount equal to the proceeds. With respect to the ACB of the note, “adjusted cost base”, as defined in subsection 54 of the Act, means the cost to the taxpayer of the property, as of that time, in accordance with section 53 of the Act. We cannot comment further on the adjusted cost base of the note in this situation as this is a determination of fact.

Situation # 2

The purpose of subsection 70(6) of the Act is to allow a deferral of tax consequences that would arise from the deemed disposition of capital property occurring as a result of a taxpayer’s death if the property is transferred or distributed to the taxpayer’s spouse or to a testamentary trust established in favour of the spouse and the other requirements of the provision are met. The result is that any capital gain that would have ordinarily accrued up to the time immediately before the death of a taxpayer would not be required to be included in the income of the deceased for the year of death on the deceased’s income tax return.

The rules in subsection 70(6) of the Act apply where any property of a taxpayer is, as a consequence of the taxpayer’s death, transferred or distributed to the taxpayer’s spouse or testamentary spouse trust, if it can be shown, within the 36 month period ending after the taxpayer’s death (or a longer period if the Minister considers it reasonable in the circumstances) that the property has become vested indefeasibly in the spouse or trust. Subparagraph 70(6)(d)(ii) of the Act provides that the taxpayer shall be deemed to have disposed of the property immediately before death and to have received proceeds of disposition equal to, in the case of property other than depreciable property, the adjusted cost base to the taxpayer of the property immediately before the death. In addition, the spouse or trust is deemed to have acquired the property at the time of death at a cost equal to those proceeds.

The deceased taxpayer’s legal representative may, however, elect under subsection 70(6.2) of the Act, to have subsection 70(5) of the Act rather than subsection 70(6) apply to any capital property of the taxpayer. In these circumstances, the proceeds of disposition of the property to the deceased and its cost to the spouse or trust are each equal to the FMV of the property immediately before death. An election made under subsection 70(6.2) must be made in the deceased’s income tax return for the year of death. We have enclosed a copy of IT-305R4, Testamentary Spouse Trusts, which contains more information on this subject.

In Situation # 2, after Mr. A’s death, pursuant to Mr. A’s will, his legal representative would transfer Mr. A’s shares to a testamentary spouse trust in exchange for a demand, secured interest-free note having a face amount equal to $700. Assuming that the requirements of subsection 70(6) are met, the CCPC shares that are transferred to the trust would be, immediately before Mr. A’s death, deemed to be disposed of by Mr. A for proceeds equal to the adjusted cost base of the shares to Mr. A immediately before his death. The trust would be deemed to have acquired the shares at that time for an amount equal to the proceeds. With respect to the ACB of the note, as indicated above, we cannot comment on the adjusted cost base of the note in this situation as this is a determination of fact.

We trust our comments will be of assistance to you.

Yours truly,

R. Albert, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

Encl: